Postcard from...China

Last October, we travelled to Wuhu in the eastern Anhui province, about 350 kilometers from Shanghai. When we woke up and looked out the hotel window, the thick gray smog that covered the city provided a potent reminder of one of China's most vexing problems: air pollution.

Chinese companies are facing increased pressure to clean up their act on environmental issues. In our visits to some of the biggest cement factories across the country, we found out what's really happening and why it matters.

That view featured in our discussions with managers and employees of Anhui Conch Cement Co., one of China's biggest cement producers. The sheer scale of the Wuhu plant, capable of producing about 44,000 tonnes of cement a day, is overwhelming. Places like this make China the world's largest cement producer by far, accounting for more than half of global production*. Driving around the highly automated facility, we saw few human workers, but massive structures belched smoke into the sky everywhere. I began to question whether the country's commitment to the environment was all smoke and mirrors.

Yet the imposing smokestacks create the wrong impression. In 2014, Chinese Premier Li Keqiang declared war on pollution. And companies like Conch have responded. The company has reduced energy consumption and emissions, while adding advanced systems to recycle heat, manage waste and control dust.

But still, from a distance, investors might be skeptical. It's easy to think that perhaps it's all just a ruse, and Chinese inspectors are tipping off the managers before they come to verify compliance with environmental rules.

We were shown this was not the case in conversations with Conch's employees. They helped convince us that environmental efforts are real. One plant manager even told us that government inspectors are so serious, they even check trees near the plant to see if leaves are covered in dust, to prevent companies from cleaning up before an inspection! This is clearly not a box-ticking process for some companies, but a cause that's being implemented from the highest level and one that most are keen to uphold.

We've watched this process steadily gain traction in recent years. When we visited a Jidong cement plant in Shijiazhuang in 2016, the government's environmental efforts were just beginning. A year later, managers from the same plant told us that surprise inspections had become routine, and inspectors were being sent from different provinces to prevent any bias or corruption.

These efforts have continued even as China copes with a painful economic slowdown. The message is clear: while economic cycles come and go, the Chinese government is signaling that it is firmly committed to cleaning up the environment.

What does this mean for investors? First, you really need to engage with company management and employees in China to know what's happening, behind the headlines. This is especially important as the Chinese stock market opens up and global investors gain unprecedented access to Chinese A-shares, listed in the domestic market. Second, ESG ratings don't necessarily provide a complete picture of improvements that companies are making in real time. By engaging with companies, investors can get ahead of the market—and work with ESG ratings companies to help companies win upgrades through better communications. Third, there's no substitute for getting a firsthand view of company operations to develop an investment thesis. Especially in China, where many companies aren't covered extensively by foreign analysts, this type of on-the-ground research is essential to developing long-term forecasts and capturing the most attractive opportunities in an equity portfolio.

_{* https://cembureau.eu/cement-101/key-facts-figures/}